Calculate the total return of the municipal bond described below.

Jane and Fabbio Salvatore have just discovered that a Fabulous Florence municipal bond will be offered to support a bridge development in Fabbio's hometown in Florence, OH. They want to purchase the bond at $1,000, but end up buying the 10% bond at $1,020. One year later, the Salvatores want to sell and earn a profit when the market value is at $1,000. Calculate the total return of the Fabulous Florence bond.

A) 12% B) 1.96% C) 7.84% D) 2%

The correct answer is C.

The test will try to confuse you by adding extra details to the questions. It doesn't matter that the Salvatores wanted to buy at $1,000 when, in fact, they bought it at $1,020. Furthermore, one year later when the market is at $1,000, their bond has actually depreciated by ($1,020-$1,000 = $20)/$1,020 = 1.96%. Note however that the total return will reflect the interest earned (yield) plus or minus any appreciation or depreciation (growth). While the bond earns 10% interest, it has lost over 1% of its value and delivers a total return of 7.84% = (1.1 x 1000) – 1020/1020